So maybe you are not a math major, and maybe you don’t do iteration based mathematics for fun, does it really mean that you should not be able to calculate present value? For some reason it has been accepted that the concept of calculating present value is complex, difficult to grasp and is used only by sophisticated savvy investors only. Maybe that’s because some sales people benefit from you having no idea of what present value is and how to calculate it, but truth is, the concept is quite straightforward, and anyone who is engaged in an investment decision process should understand it.
At Structured Settlement Quotes, we believe that it is essential for individuals seeking to sell annuity payments to understand this concept so they can have a fair appreciation of how much their structured settlement payments are worth. Time and time again we witness how factoring companies abuse the present value formula to provide clients with ridiculously low quotes.
It’s a fact of life that things get more expensive, for example, in 1962 a burger went for 20 cents, now 99 cents, wranglers double mint chewing gum cost 5 cents then now were up to 50, Penn university of Pennsylvania cost 1250 in 1960, now were up to over 42,000, average cost of a car went up from 2,600 in 1960 to 32,000 last year, and so on and so forth.
Remember, the idea of present value is that money today is worth less than money tomorrow. Usually, it is easier to start by looking at the inverse of that. That is, with the assumption of 10% rate of return, $100 today worth exactly $110 in the future. The reverse is exactly the same. Let me explain by breaking down this concept to its three main components:
By definition (using investopedia), present value is ‘the current worth of a future sum of money or stream of cash flows given a specified rate of return’ . It is calculated by discounting the future sum of money by the specified rate of return, taking into account the time value of money;
(1) Future sum of money is simply future payment(s). In your case it is most likely one, or more future payments paid by the insurance company. For illustration purposes, assume you receive one future payment one year from now, let’s call it ‘F1=$110’.
(2) Specified rate of return (also known as the discount rate) is the appropriate rate at which we discount the future cash flow. The key is to determine this rate. As a general rule of thumb, this rate is determined by looking at similar comparable investment products and their associated rates, as determined by investors. Let’s call it ‘r=10%’.
(3) Time means month(s) or year(s), depending on when in the future the payments are received. Let’s call it ‘t =1(year)’.
Now, to calculate the present value all we need to do it to discount the future payment while also taking into account the time of the payment. The formula is PV= (F1)/(1+r)t, or in our example PV= (110)/(1+10%)1 in this case PV equals $100. A more complex case would include more payments in different times, but the concept remains the same: present value is the current worth of future payments.
We believe that it is important for you to try and understand this (at least on the conceptual level) before you sell your structured settlement annuity payments.
Now that you understand this concept, we invite you to do the same thing we did after we learned how to multiply, we invite you to use a calculator!
Please visit our Structured Settlement Calculators Where you will find:
Effective Rate and Nominal Annual Rate Calculator
and Structured Settlement Discount Rate Calculator
